Forget Wealth Building to Retire Comfortably

If you want to be happy in retirement, having a million dollar nest egg hardly gets you there.

All over, financial planners advise us to have a certain figure in mind when it comes to retirement. “Based on your current salary, you need $1.2 million by 65″, they might say. But yet, as history has shown, aiming for a numerical dollar amount by a certain age is like driving your car across a railroad track and hoping that you won’t get hit. Even if you reach your goal of $1.2 million by the age of 63, it could drop to $900,000 by 65, but jump back up to $1 million by the age of 66. If you are really trying to follow the advice of having $1.2 million, isn’t that a recipe for a heart attack?

An Easier Way to Think of Retirement

I would also argue that even if you meet the retirement figure, you will try hard not to spend it because seeing a decreasing account balance all the time is hardly comforting.

Therefore, an easier (and care free) way of thinking about retirement is to consider the income you could generate by the time you want to relax. For some, it could be $3,000 a month. For others, it would be $5,000 but you get the idea. As long as you have a similar amount coming in every month, you don’t need to worry about your nest egg at all.

Why It’s Better

Thinking about income early promotes a few additional benefits.

The Goal More Directly Relates to The Issue at Hand – Instead of guessing a withdrawal percentage, what the market will do tomorrow or whether you need to save 12 or 13 percent of your take home pay, an income eliminates a bunch of assumptions and guesstimates.

More Predictable – If you have money coming in every month, it’s much easier to spend it as long as you can count on the next payment.

The Goal is Harder to Reach – Implicitly, generating this income is harder to achieve than getting to a figure where you need principal plus interest to sustain your lifestyle. This promotes more savings, which is ALWAYS a good thing.

Keeps You Investing – If you start early and is smart enough to reinvest the income that you generate even before retirement, you will reap huge benefits of regular investing and compound interest.

Less Transaction Fees – When you need to sell your stock or your vacation home to fund your retirement, it usually means paying for the service. If you are focused on income generating assets, then you never have to sell, saving you of all those transaction costs.

What Type of Investments to Look For?

So where can income come from during retirement? Here’s a few areas where you can start looking.

Rental Property or REITs – While tenants come and go, most landlords who own their rentals outright aren’t really affected much by economic downturns because most tenants still stay in their homes. Another option is REITs because of its high yield.

Dividend Paying Stocks – Consider owning several dividend paying index funds for your portfolio like SDY or DVY. While the performance can go up and down, the dividend is much more dependable than any individual stock.

Stable Value Funds – These are only available in 401k plans and the yield is generally quite low, but they generate consistent income month after month.

Bonds and Bond Funds – If you are buying a bond for income only, you can safely ignore the price fluctuations as long as you buy a safe bond that have a low chance of default. For some added safety and less hassle, you may find that a bond fund (which invests in several bonds on your behalf) would serve you better.

Social Security – Chances are good that Social Security (or some equivalent) won’t be completely gone when you retire even if you are in your 20s. However small, there will be some benefits by the time you take contributions.

Part Time – Many people don’t want to think about part time jobs, but it doesn’t have to be a job per say. Many people can earn a little bit of income doing something they enjoy, like making small handcrafts and selling them online for example. Others may be able to offer their expertise as a consultant. When you are working 2 hours a day, I bet you won’t be too stressed out even if you are supposed to be retired.

Start Thinking about Your Retirement Income Now

Don’t just navigate away from this post and do nothing just because you are young and retirement is decades away. The earlier you start, the better your chance of meeting your goal.

Also remember about diversification. Some people will try to build a real estate empire while others will try to learn everything about the stock market. The prudent ones however, will do both.

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The point of your post is so important – wealth means nothing if it cannot provide a retirement income that is guaranteed to last and that is protected against inflationary damage. Right now, the only investments that can provide both are TIPS and I-Bonds. So it would be wise to have a portfolio of them to meet your essential retirement income needs. Use what is left over to invest in other assets.

This is for everyone else who is reading this. TIPS (treasury inflation protected securities), i-bonds (or any other type of investments) may or may not work for you. Please make sure you understand what they are before you go ahead and make the investment. Every asset class carry its own set of risks. (yes, even TIPS).

I’m not sure what TIPS risk you are referring to. TIPS bought and sold on the secondary market do fluctuate in value but I do not advocate trading in TIPS on the secondary market. Buy them at auction and hold them. TIPS held to maturity have no risk short of government collapse or refusal to honor them. If that happens, no assets except food and guns will have much value. I-Bonds are not traded on the secondary market, earn interest for 30 years, and can be redeemed at any time with no loss in principal. The only relatively safe income source in your list is Social Security. I used to own a number of excellent dividend-paying stocks for the same reason you listed them. Most of the best were in financials. Guess what happened to them? The yield of stable value funds typically is no better than a TIPS coupon rate plus TIPS give you the inflation protection which stable value funds do not. Many 401(k) plans will allow you to purchase TIPS inside the plan which is the best way to do it. If not, use an IRA. I-Bonds are tax-deferred which means you can safely own them in a taxable account. In many cases, REIT dividends are taxed as ordinary income which impairs their value as an income source.

The risk you are referring to is a lost of capital, but what if inflation isn’t a big problem in the next decade or two? Since the real return of TIPS is so low, there’s opportunity risk.

I’m not saying that TIPS isn’t a great investment, as it is. All I’m saying is for everyone to make sure they know what they are getting into and to not invest just because they saw it mentioned on a website, TV or magazine.

I’m just trying to write out the fine print in a not so fine print way

Good point on the opportunity risk but to me that only applies to money you could afford to lose to begin with. When you are trying to secure a basic retirement income, you have to trade opportunity cost for guaranteed income that is inflation protected. It’s analogous to purchasing homeowner’s insurance or disability insurance – protecting yourself against a devastating worst-case scenario.

I like your point about income. Shooting for a total number of assets may not provide you with the cash flow you need. Instead, focusing on income can help you figure out how to create regular inflows that meet your financial needs.

…and not to mention the age old concept that money makes money. The way I see it wealth creation is really a process of accumulating funds from which you’ll derive an income that will ultimately replace the part where you have to go to a job in order to earn it.

A theory, as one grows old, the likely hood to get a job or to be hired is very unlikely and diminishing. Therefore, it is imperative to create some nest e.g. like some rental income you had mentioned in your post, to support oneself until he/she is gone.

It’s easier to look into short run than long run so it’s easier to set and meet monthly contribution goals than look 40 years down the line to a number that in your mind is just a number and not reality.

The flaw with the monthly contribution goals theory is that it’s based on too many assumptions. I hear about the rule to save 10% of your income all the time, but it doesn’t say anything about how much you make, what to invest it in, when you have to start etc, so it’s definitely not something I can just blindly follow.

I like the way you think. But one flaw in this logic: Wouldn’t the income vary from time to time? Couldn’t a rental property sit empty for a prolonged period of time? Couldn’t a stock start playing less of a dividend (or tank like Citi did)? Plus I’m sure as heck not counting on social security more than 20 years down the road.

I understand it’s impossible to get a consistent income that doesn’t fluctuate, but my point is that it takes even more. You want to have a certain amount of wealth (especially wealth locked up in gold that will always be worth something) as well as an income figure in mind. Plus I think a good hint is to always shoot high because of potential losses (i.e. the past year or so).

You are right. Now that I think about it, I falsely assumed that people will automatically create a cushion since I couldn’t believe someone would spend ALL of the retirement income that comes in every month, even if it was pretty steady.

Also, having a diversified portfolio where some form of income is coming from different assets will soften the effect of one non-performing investment.

In this post, I’m claiming that everyone should look into incomes for retirement, but it doesn’t mean that once you picked a few investments, it goes into autopilot.

Very good points indeed, and I’m glad I found your page. I’ll be checking back often. I’m a firm believer in savings, and in income generation through sources other than a job. I’m also a firm believer in retiring, or at least stopping working for someone else, well before traditional retirement age.

Ning,
I was also operating under the belief that I had to have a certain amount of money in my bank account when i retired. Like you mentioned, thinking about my retirement plans in terms the monthly income I have to have makes it all seem a little less depressing. Thank you for the sound advice.

Allow me to second (or third) the idea of focusing on income. I never want to see my principal decrease. And, one should be very careful to diversify among many asset classes — there are a host of safe, high-paying securities most investors have never heard of. You just have to do your due diligence, including a thorough stress test of each security and the company behind it. Then it’s possible to enjoy the benefits of solid income without stress.

It all sounds like pie in the sky to me. I am retired. I have some rental houses but the income and expenses can vary wildly from year to year. Most of my income comes from laddered CD’s. The ladder is mature with all 5 yr rungs. The interest rates average 5%. This is so much higher than inflation protected bonds. There’s no way to escape the fact that if you want your money to do some heavy lifting with reliability you need 1.2M when you retire and much of it needs to be in laddered 5 yr CD’s. You still have to eat if you lose your tenants and need to replace a roof.

I like the way your post is thought provoking. I love that you take an alternative approach. You see that what most financial planners are doing is setting people up for failure. I love that.
Let me ask you your take on something. An annuity. What I mean by that is creating a guaranteed income stream for life. This can also have inflation increases built into it. Do you like these? I mean this is what the traditional pension plans of the past did for people. It took their focus off of investing and gave them an annuity for life.

I firmly believe people need to take the time and take personal attention to their finances. This business of ‘turning over ones wealth to an expert’ has never sit well with me, but then I actually enjoy the process of investing. In my view annuities can be an interesting and even attractive vehicle for fixed income, but I think they fit better in a portfolio after retirement, not before. Before retirement one should be more focused on growth, something an annuity doesn’t offer.

Like others have said, annuities are expensive and there’s a very good chance that other investments are a much better bet. However, there’s nothing for sure in life and there’s a minor chance that an annuity will pan out better than others. An annuity can give lifetime payments, so for some that are very risk adverse, it works very well.

However, just make sure that you spread your investments out to different insurance companies because a company that goes bankrupt won’t be paying out your annuity.

Having had rental properties in the past – can agree wholeheartedly with D’Anna’s comments above…beware, it’s not always roses with rentals.
Some tenants honestly believe all their rent $$$ stay in the landlord’s pocket – and they deeply resent even tiny rent increases to offset the landlord’s increased expenses over time.

We’ve always regarded our retirement financial assets as income-producing buckets, not meant to be spent themselves. Those who blindly follow the advice to take out a fixed percent of total assets per year while in retirement risk running out of funds. Recently read an article which wisely councils taking out a variable amount based more on true needs and considering the amount of $$$ generated each year.

That advice helps a lot right now, as our CDs mature at one rate and renewal options offer less than half the old rate. OUCH…

At a glance we can get monthly balance & income info. on individual accts., the total amount at each institution or category. There’s further breakdowns into currently taxed and tax-deferred accts. to help with estimated income tax filings.

In addition, we use a simply handwritten Personal Monthly Budget Sheet which lists the various bills and expenses over the current month. Very good to use when creating a yearly budget.

It may sound involved and a hassle – but it’s not and it really doesn’t take that long – unless you’ve got really huge amounts involved – and it often helps to answer questions about how you got to where you are financially.

Great advise here…I have been looking at investing in REITS myself and have in fact started on one last December 2010. I’ve also invested in high dividend paying stocks such as gas pipeline related companies. And I could not agree with you more in regards to going for a continuous flow of regular retirement. Just can’t beat that.

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